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Why Falling Oil Prices are NOT a Reason to Celebrate

Normally, consumers consider falling oil and gasoline prices to be good news. They have to pay less to fill up their tanks. And if the reason for that is that oil supplies are increasing at a rate faster than demand is increasing, it can indeed be a good situation for consumers, and good for the economy.

But here’s the bad news: That is not the case today.

Oil prices fell last week to below $90 a barrel, their lowest level in six months. I think oil prices are likely to fall further in the short term, and gasoline prices won’t be far behind. While this news alone does mean that consumers will get some relief, the broader picture is grim. The reason oil prices fell by so much is not because a lot of new production came online, but rather because the economy is very sick, and a lot of people are out of work. Economic activity continues to be weak, and that means demand for oil is expected to be weak. In short, not as many people can afford oil and the things made from oil.

However, oil is a global commodity, and some economies continue to boom. Therefore, I don’t expect prices to go down and stay down. Growth in just China and India will see to that. And thus we have a dilemma that led me to the Long Recession hypothesis. It essentially says that when there isn’t much spare oil production capacity, growth in developing countries will tend to keep oil prices high. But high oil prices are a drain on economies that are highly dependent upon oil (like the United States). Thus, if oil dependent countries are in recession during a time that oil production capacity isn’t growing (or worse, shrinking), they are going to have a pretty tough time coming out of that recession. (More details on my reasoning can be found here).

Or a simpler way to put it is this. It may be that the U.S. economy and our per capita oil consumption of 23 barrels of oil per person per year can’t grow in the face of $100 oil. But if countries like China and their 2 barrels of oil per person per year continue to grow while buying $100 oil, then we have truly entered a new paradigm. What may happen is that both China and the U.S. end up consuming 5 or 8 barrels per person per year, which could still grow China’s economy, while the U.S. gets there by shrinking ours. In my upcoming book, I address what I believe are the most serious energy-related threats to the U.S. economy in the years ahead. China’s growth is probably the most worrisome factor because we will be competing against them for global oil supplies.

George W. Bush, Barack Obama, and the U.S. Deficit

Some would argue that oil isn’t the biggest story here. And certainly there are plenty of other issues at play. Over the past decade, the United States went on a spending spree, and yet our taxes were cut at the same time. Our deficit ballooned. And while I gave my reasons recently for thinking that President Obama’s tenure has and will continue to be mediocre (which even his staunch supporters are starting to acknowledge), let’s not pretend that he created this situation. He might not have done a lot to make it better — and one can argue that he made it worse — but it was clear when he took over that he had his work cut out. It wasn’t like he was handed a robust economy and then ran it into the ground (it is much easier to argue that Bush II did just that). I commented many times during the presidential campaign that whichever candidate won had a very difficult presidency in store. I thought Obama would win, and the night before the election I wrote “He is going to preside over a difficult four years.” I think we can safely say that this has been the case so far.

Why did I believe that? Oil prices were one thing. I thought they would continue to be a drag on the economy; that as the recovery gained steam high oil prices would again slow things down. But I also felt like our deficit spending had gotten totally out of control, and after President Bush finished his spending binge someone was going to have to make some very tough decisions to keep the United States from declining into mediocrity. It would take political leaders with courage.

The New York Times recently published a story on exactly how the deficit got so out of control. In that story was a graphic comparing the deficit contributions of President Bush and President Obama:

That is pretty shocking. There is one obvious flaw in that graphic, and that is that one is based on 8 years of the Bush Administration, and one is based on 2 and a half years plus projections for future years under Obama. It could turn out that 8 years of an Obama Administration will add as much or more to the deficit, but one thing is indisputable: President Bush spent a lot of money on his priorities without coming up with the revenue to pay for them — either through tax increases or by cutting other programs. That was irresponsible, and we will pay for those decisions for years.

Some have argued that the budget deficit as a percentage of our overall gross domestic product (GDP) was pretty typical under Bush. We can check that as well. From the Wikipedia article on United States public debt:

That graphic shows that the deficit (relative to GDP) under Bush II had begun to grow shortly after he took office, and after falling under Clinton. To be fair, that also coincides with the slowdown after the 9/11 terrorist attacks and then we went immediately into war with Afghanistan. The deficit grew throughout the Bush Administration, but then really took off as the recession started to bite and Bush went on a spending spree to kick-start the economy. Under Bush we had the TARP bailout, the Economic Stimulus Act of 2008, ongoing wars in Afghanistan and Iraq, and a Medicare drug entitle¬ment — to name a few — and we left the bills for our children to pay.

The most shocking thing on that graphic was to see deficits falling under Democrats and increasing under Republicans. Given that Democrats are considered the “tax and spend” party and Republicans are traditionally presented as the fiscally conservative party, that graphic is a shocker to me personally. One caveat that should be noted on that graphic though: If I understand the disclaimer correctly, the way they draw the borders on the administrations extends into the following administration. So if I understand it correctly, the end of the Clinton graphic was actually 9 months into Bush II’s term, and the end of Bush’s graphic was 9 months into Obama’s term (the end of the Oct. 1st fiscal year that began in the predecessor’s term). The reason given for that is that the previous administration’s budget is primarily responsible for the deficit behavior until the end of the fiscal year.

Of course President Truman did manage to take a similar situation — a deficit that exploded with World War II — and turn that around. In doing so, his administration was so unpopular that people were stunned when he was reelected. But besides presiding over lots of labor unrest, President Truman also presided over a country where oil production was growing rapidly and contributing to the overall economy. At present, our oil consumption is draining money from the economy by sending a lot of money out of the country.

When President Obama took office two years ago, the national debt stood at $10.626 trillion. It now stands at $14.071 trillion — a staggering increase of $3.445 trillion in just 735 days (about $5 billion a day).

To put that into perspective, when President George W. Bush took office, our national debt was $5.768 trillion. By the time Bush left office, it had nearly doubled, to $10.626 trillion. So Bush’s record on deficit spending was not good at all: During his presidency, the national debt rose by an average of $607 billion a year. How does that compare to Obama? During Obama’s presidency to date, the national debt has risen by an average of $1.723 trillion a year — or by a jaw-dropping $1.116 trillion more, per year, than it rose even under Bush.

I post that to show that there is plenty of blame to go around. Democrats who blame Bush are partly right, and Republicans who blame Obama are partly right. But at the end of the day, it doesn’t matter which guy was bad and which was worse. Each has made a major contribution to this mess.

When the Bills Come Due

So where do we stand after this decade-long deficit spending spree? At the end of last week, as the stock market was crashing, it was reported that the jobless rate fell, seemingly positive news. Not so fast, said USA Today:

It’s a product of something the government calls “discouraged workers,” or those who were unemployed but not out looking for work during the reporting period.

This is where the numbers showed a really big spike—up from 982,000 to 1.119 million, a difference of 137,000 or a 14 percent increase. These folks are generally not included in the government’s various job measures.

So the drop in the unemployment rate is fairly illusory—stick all those people back in the workforce and you wipe out the job creation and the drop in unemployment.

S&P said that in addition to the downgrade, it is issuing a negative outlook, meaning that there was a chance it will lower the rating further within the next two years. It said such a downgrade to AA would occur if the agency sees less reductions in spending than Congress and the administration have agreed to make, higher interest rates or new fiscal pressures during this period.

In its statement, S&P said that it had changed its view “of the difficulties of bridging the gulf between the political parties” over a credible deficit reduction plan.

S&P said it was now “pessimistic about the capacity of Congress and the administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics anytime soon.”

This downgrade will cause interest rates to tick up, which raises the cost of borrowing money and impacts government and consumers alike. It is an additional drain on an already anemic economy. The Obama Adminstration cried foul over the downgrade, but what did they expect? If a person borrowed more money year after year than they earned — and then started openly discussing default — would we expect anything differently? (To be clear, I am not blaming Obama for the default talk). Instead of criticizing the downgrade, I think what Obama probably should have said was “What did we expect? Look at the debt-reduction fiasco that just played out. It is a strong signal that we need to get our fiscal house in order.”

Conclusion: Cloudy With Thunderstorms Likely

I honestly see no easy way out of this mess. Spending will have to be cut, and nobody wants to lose out on money being spent on them. By almost every credible analysis I have seen, taxes are going to have to be raised — because we have to pay for things we spend money on. But nobody wants to see their taxes raised either.

There is going to be an enormous amount of lobbying as groups seek to have the pain pushed off on to other groups. The President and Congress are going to work against each other because they have different ideas of what is needed to address the issue. Meanwhile, neither side has put on the table anything that can realistically bring the deficit back under control in the foreseeable future. That will take real pain, and politicians don’t like to bring the pain. It is hard on their careers, so it will take courageous leadership to do the right things.

I would really like to see a publicly televised discussion where leaders from both major parties stand up, show the data, and then present their solutions. Instead, all we get are sound bites: “Democrats want to raise your taxes!” or “Republicans want to take away your Social Security!” I saw a recent CNN story where John King broke down the spending of the United States (video here), and showed the different scenarios of what might have to be cut if the debt ceiling was not raised. It certainly appeared to me that the cuts would extend deeply into programs that impact the majority of Americans, so this is the information I would like to see presented and discussed by the political leaders. If a program is wildly popular but still putting the country into a deep deficit hole, then raising taxes must be on the table. If raising taxes is not on the table, then the politicians keeping it off the table have to offer the specifics on what they would cut in order to bring revenue in line with spending.

Some people think things aren’t so bad. I heard one talking head predict that we were about to come out of recession. I disagree. I think things are worse than most people believe, and I am more convinced than ever that the Long Recession will continue unabated. I am with that list of people documented here — Ben Bernanke, Alan Greenspan, George Soros, Paul Krugman (Nobel Prize in Economics), Joseph Stiglitz (Nobel Prize in Economics), Nassim Nicholas Taleb (author of The Black Swan: The Impact of the Highly Improbable – a fantastic book that I read in 2007) — who believe that the ongoing economic crisis could ultimately be worse than the Great Depression.

In conclusion, I am not — nor have I ever been — a Doomer. But I don’t see a lot to be optimistic about over the economy, and I think we are going to endure tougher times ahead.

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What you fail to mention is that it is Congress that makes the US budget, not the President. It would be more useful to see the deficit graph versus which party was in control of Congress.

Anonymous on August 10 2011 said:

Spin this any way you want but lower oil prices ARE BETTER for the economy. Energy prices were the match in '08 that started this mess. Lower oil prices should mean lower prices on consumer goods because of transportation costs which in turn means people can afford more which in turn means more people needed to make the products which means more jobs which means a better economy. Experts are idiots! They don't live in the real world or know how the average person lives. I live it, I'm the expert!

Anonymous on August 10 2011 said:

While raising taxes seems like it would help erase some debt, aren't you missing the point that washington has a spending problem? If you just cut spending, not much will get done. If you just raise taxes, washington sees it as more money to spend. As someone who doesn't want their taxes raised, id be ok with it if there was a cap on spending, that way you cut the deficit from both ends.

Anonymous on August 10 2011 said:

While raising taxes may sound like the only way, its not and won't work because washington has a spending problem. More revenue means they will spend more. No one likes taxes, especially not me, but if washington put a legal cap on their own spending, then taxes could be raised and the debt could be tackled from both ends.

Anonymous on August 11 2011 said:

The problem I see with raising income taxes is this: If you give a compulsive gambler a thousand or a million dollars to pay off his gambling debts, he will invariably take the money you give him and gamble some more. Government reminds me of a compulsive gambler. I say, keep income taxes where they are and force our congress to stop the pork-barelling. Stop programs which serve no constituency other than the neurotic needs of the intellectual classes. Go back to the original intent of our country's founding fathers, which was to organize a federal government to provide for the common defense (i.e. Army, Navy) but leave care and education of our children to local governments and local social structures. And finally, stop Obamacare.

Anonymous on August 18 2011 said:

The way I see it, is this in 2012 we all vote for NONE OF THE ABOVE then then congress will put a puppet in the White house and then in 2014 when congress and the senate have their turn we all VOTE FOR NONE OF THE ABOVE. Then at that time we put a limit on time they have in office if your President and Governors have a 8 year limit then so should the congress and senate have a maximum of 8 years in office and we cap their pay and no automatic raises (if we the people don’t get a raise then they don’t get a raise) that’s the way it should work. I’m pretty sure that George,Abe and Thomas Jefferson did not need millions of dollars to run for office, it’s time to clean house it’s really full of Greedy Rats and it’s time to start over with fresh new ideas.

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